Is E&M (KOSDAQ:089230) Using Debt Sensibly?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that The E&M Co., Ltd. (KOSDAQ:089230) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for E&M

What Is E&M's Net Debt?

As you can see below, at the end of December 2020, E&M had ₩12.4b of debt, up from ₩11.3b a year ago. Click the image for more detail. But on the other hand it also has ₩41.1b in cash, leading to a ₩28.6b net cash position.

A Look At E&M's Liabilities

We can see from the most recent balance sheet that E&M had liabilities of ₩32.6b falling due within a year, and liabilities of ₩5.14b due beyond that. Offsetting this, it had ₩41.1b in cash and ₩12.1b in receivables that were due within 12 months. So it can boast ₩15.3b more liquid assets than total liabilities.

This surplus suggests that E&M has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, E&M boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is E&M's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year E&M wasn't profitable at an EBIT level, but managed to grow its revenue by 36%, to ₩61b. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is E&M?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that E&M had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through ₩23b of cash and made a loss of ₩25b. Given it only has net cash of ₩28.6b, the company may need to raise more capital if it doesn't reach break-even soon. With very solid revenue growth in the last year, E&M may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for E&M you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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